Challenges in implementing value-based pricing strategy

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Industrial Engineering and Management

Henri Rantalaiho

Challenges in implementing value-based pricing strategy

Master’s thesis

Espoo, Finland 21.05.2017

Examiners: Professor Asta Salmi, Associate Professor Joona Keränen Case Company Supervisor: Kalle Aerikkala

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Title: Challenges in implementing value-based pricing strategy Year: 2017 Place: Espoo

Master’s thesis, Lappeenranta University of Technology, School of Business and Management, Industrial Engineering and Management

74 pages, 11 figures, 26 tables, 1 appendix

Examiners: Professor Asta Salmi, Associate Professor Joona Keränen

Keywords: Pricing, value-based pricing, pricing strategy, pricing organization, pricing management, barriers to value-based pricing

The decline of raw material prices as has increased price pressure and created need to develop pricing strategies for metals and minerals processing equipment vendors. Value- based pricing strategy is considered to offer best possibility to maximize revenue.

However, value-based pricing is not commonly adopted in industrial markets.

Organizational issues have been recognized as the key obstacles of implementation of value-based pricing strategy. The objective of this study is to provide information about the challenges and the development needs of pricing management in industrial markets especially related to the implementation process of value-based pricing strategy.

The study was conducted using single case study method with. As a basis for the study, the current literature involving strategic pricing, pricing management and value-based pricing was studied. The data was collected by conducting eleven interviews. Data was analyzed by using open and axial coding.

Eight main themes related to pricing management and the role of the pricing function where identified. Twelve individually and organizationally induced barriers to implementing value-based pricing were recognized. Findings correlate with current literature concerning the effects of barriers to value-based pricing strategy. The importance of senior management support and the need for co-operation in implementation process of value-based pricing strategy were emphasized.

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Työn nimi: Haasteet arvopohjaisen hinnoitelustrategian implementoinnissa Vuosi: 2017 Paikka: Espoo

Diplomityö, Lappeenrannan teknillinen yliopisto, School of Business and Management, Tuotantotalous

74 sivua, 11 kuvaa, 26 taulukkoa, 1 liite

Tarkastajat: Professori Asta Salmi, Tutkijaopettaja Joona Keränen

Avainsanat: Hinnoittelu, arvopohjainen hinnoittelu, hinnoittelustrategia, hinnoitteluorganisaatio, hinnoittelun johtaminen, arvopohjaisen hinnoittelun esteet

Raaka-aineiden hinnan lasku on nostanut hintapainetta ja synnyttänyt hinnoittelustrategioiden kehitystarpeen metallien ja mineraalien prosessointilaitteiden toimittajille. Arvopohjaista hinnoittelustrategiaa pidetään parhaana vaihtoehtona tuoton maksimoimiseen. Arvopohjainen hinnoittelustrategia ei ole kuitenkaan yleisesti omaksuttu teollisilla markkinoilla. Organisatoriset ongelmat ovat tunnistettu merkittävämmiksi esteiksi arvopohjaisen hinnoittelustrategian implementoinnissa. Tämän tutkimuksen tarkoituksena on tarjota tietoa hinnoittelun johtamisen haasteista ja kehitystarpeista teollisilla markkinoilla eritoten liittyen arvopohjaisen hinnoittelustrategian implementointiprosessiin.

Tutkimus suoritettiin yksittäistapaustutkimuksena. Tutkimuksen pohjaksi tutustuttiin olemassa olevaan kirjallisuuteen koskien strategista hinnoittelua, hinnoittelun johtamista ja arvopohjaista hinnoittelua. Tutkimuksen aineisto kerättiin suorittamalla yhteensä 11 haastattelua. Aineisto analysoitiin avoimella ja aksiaalisella koodauksella.

Kahdeksan pääteemaa liittyen hinnoittelun johtamiseen ja hinnoittelufunktion rooliin identifioitiin. Tämän lisäksi tunnistettiin 12 henkilökohtaisesti ja organisatorisesti aiheutuvaa pääestettä arvopohjaisen hinnoittelun implementoinnille. Tulokset korreloivat olemassa olevan kirjallisuuden kanssa koskien arvopohjaisen hinnoittelustrategian pääesteiden vaikutuksista. Ylemmän johdon tuen tärkeyttä ja yhteistyön tarvetta osana implementointiprosessia korostettiin.

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In autumn of 2014 I was supposed to have an interview for position of Master’s Thesis worker in Outotec. One week before the interview, the topic changed into job interview for position of full-time Pricing Specialist. Although I understood that it could be quite demanding to combine working and writing thesis simultaneously I decided to challenge myself and accept the position. Now, two and half years later, I can say I did it. The process of writing this thesis has been extremely humbling experience and I have learned about myself many new things. Journey has been long and challenging but at the same time rewarding, especially now on the brink of finishing my Master’s studies.

This could not have happened without support. Thank you Outotec for giving me this opportunity. Especially I would like to thank Kalle Aerikkala for introducing me into the interesting yet complex world of pricing. I cannot also thank enough my supervisor from LUT, Joona Keränen, who initially put healthy pressure on me to finish my studies and supported me throughout the process of writing this thesis. Thanks belong also to all my colleagues and friends who were always there for me when I had difficulties with the writing process. Special thanks to IBK MedA for reminding me that with winning culture only the sky is the limit.

Last, but not the least, I want to thank my family. Thank you Henriikka for sharing your tips on finishing studies. Thank you Heikki and Irene, you have always supported me whatever I have decided to do. I know I can always count on you in the most difficult times and I will never stop being grateful to you for how good you have been and still are as parents to me.

Espoo, 21.05.2017 Henri Rantalaiho

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LIST OF FIGURES

Figure 1. Steps of pricing management development in Case Company ... 3 Figure 2. Consideration in setting price (adopted from Kotler & Armstrong, 2012, p.291) . 6 Figure 3. Pricing chain of different pricing strategies (Hinterhuber & Liozu, 2013, p.108) . 7 Figure 4. Economic value (Nagle et al. 2014, p.20) ... 13 Figure 5. The Strategic Pricing Pyramid (Nagle et al., 2014, p.7) ... 14 Figure 6. Individually perceived barriers to VBP and the legitimation of VBP (Töytäri et al., 2017, p.244) ... 25 Figure 7. The location of the constructive approach into the established accounting research approaches (Kasanen et al., 1993, p.257) ... 32 Figure 8. Typology of participant observation research roles (research methods p.293) .... 33 Figure 9. Interviewees based on responsibilities ... 37 Figure 10. Pricing function’s position in overcoming barriers to VBP ... 66 Figure 11. Framework for successful implementation of VBP in Case Company ... 70

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LIST OF TABLES

Table 1. Structure of the research ... 4

Table 2. Individually, organizationally, and externally induced barriers to value-based pricing (Töytäri et al., 2017, p.241) ... 24

Table 3. Overcoming the obstacles to value-based pricing (Hinterhuber & Bertini, 2011) 26 Table 4. Interviewees codes, titles and responsibilities ... 36

Table 5. Importance of product specific pricing ... 39

Table 6. Requirement for customer specific pricing ... 41

Table 7. Effect of geographical location to pricing ... 42

Table 8. Role of price in sales activities ... 44

Table 9. Collaboration between headquarters and market areas ... 45

Table 10. Ownership of pricing decision and procedures ... 46

Table 11. Changing prices ... 46

Table 12. Communicating value to customers ... 47

Table 13. Complexity of VBP ... 48

Table 14. Challenges in quantifying the value ... 49

Table 15. Issues in sales and pricing processes ... 51

Table 16. Questioning competences for VBP ... 52

Table 17. Relying in technical expertise ... 53

Table 18. Obscurity in evaluating VBP ... 53

Table 19. Inability to influence customer’s price requests ... 55

Table 20. Insufficient level of expertise in product portfolio ... 55

Table 21. Limited data transparency ... 57

Table 22. Need for better customer and sales case selection ... 58

Table 23. Lack of empowerment ... 59

Table 24. Issues in supporting value sales ... 59

Table 25. Pricing management in Case Company ... 61

Table 26. Barriers to VBP in Case Company ... 62

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LIST OF SYMBOLS AND ABBREVIATIONS

B2B = Business to business

ERP = Enterprise resource planning HR = Human resources

IPR = Intellectual property rights KPI = Key performance indicator PDM = Product data management RFQ = Request for quotation R&D = Research and development VBP = Value-based pricing

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1 INTRODUCTION

1.1 Background and motivation

“Price management is a critical element in marketing and competitive strategy and a key determinant of performance” (Shipley and Jobber, 2001, p.301). Despite the importance, pricing is often overlooked compared to other elements of marketing mix. Focus is seen to be just figuring out what are market price levels and trying to cope with price management towards competitors. (Lancioni, 2005a.) Same trend has been seen also seen in academics as subject of pricing has received significantly less attention when comparing number of publications on other instruments such as product, promotion and distribution (Hinterhuber, 2004). According Ingenbleek (2007) due increased market pressure towards prices more effort has been put to understand customers’ value perceptions. Value-based pricing strategy (VBP) has been seen as most superior pricing strategy towards others as it is understood that it generates best possibilities of maximizing revenues by taking account the aspect of customers’ willingness to pay (Hinterhuber 2008).

Due declined raw material prices mining and metals processing companies have had less money to invest in their operations. This has led to increased price pressure for equipment vendors in the markets. Simultaneously due globalization number of competitors has increased especially in lower cost countries providing products with cheaper prices. As the demands and the level of competition has been increasing in mining and metals equipment vendors have faced needs to develop their pricing management in order to survive in industrial markets. As the characteristics and value perceptions vary between different customers in the markets, utilizing VBP has gained the interest among industrial vendors.

Despite the benefits customer value-based pricing still plays a minor role in pricing strategies appointed especially in industrial companies whereas cost-based and competition-based pricing strategies are more common used (Hinterhuber & Liozu, 2014).

In order to understand better why VBP is employed so infrequently literature suggests that

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organizational issues are playing a key role in preventing implication of value-based pricing (Hinterhuber 2008, Töytäri, Rajala & Brashear Alejandro, 2015). On a single case study in a global industrial firm Töytäri, Keränen and Rajala (2017) acknowledge that individually induced barriers have significant influences on preventing implementation of VBP.

Töytäri et al. (2017) suggests that further research might provide additional information about the barriers to VPB. In this research focus is to study what are key barriers towards VBP and recognize specific barriers from key internal stakeholder’s perspective with single case study. Research aims to shed light about the challenges related to implementing VBP and to recognize specific barriers induced in Case Company. In order to recognize barriers study is also concentrating in creating understanding how pricing management is seen in Case Company.

Case Company is Finland-based global firm providing technologies and services in the field of metal and mineral process technology. Although Case Company’s products are globally recognized as being highly competitive from technical and quality perspective, customers have expressed readiness to choose alternative products from competitors, even with lower quality and prices. However taking part in pricing wars is not in Case Company’s interests and therefore it has been recognized that emphasis needs to be in increasing customers willingness to pay instead of “throwing the towel” on pricing. This has led Case Company to develop its pricing management during last years. Phases of pricing management development are illustrated in Figure 1. Major breakthrough towards pricing management happened in year 2014 when separate pricing team was established and sophisticated pricing management system was deployed. One of the major tasks given to services pricing team in 2014 was implementing VBP throughout Case Company’s service functions. As there has been significant, progress during last three years in terms of implementing VBP it is also evident that obstacles have arisen among the journey.

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Figure 1. Steps of pricing management development in Case Company

1.2 Research questions

The objective of this study is to provide information about the challenges and the development needs of pricing management in industrial markets especially related to the implementation process of value-based pricing strategy. In order to recognize obstacles to implementing VBP there is also need to explore how different aspects related to pricing management and the role of pricing function in this context are understood organizationally. To address the objective of this study single-case study is conducted and issues are analyzed in Case Company.

The research questions of this research are:

1. How pricing management and the role of pricing function is understood in industrial companies?

2. What are the key barriers that prevent implementation of value-based pricing strategy in industrial companies?

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1.3 Research structure

Theoretical part consists of two parts that are pricing in general and implementing VBP. In first theoretical part, strategical aspects of pricing as well as pricing management from organizational perspective are discussed. This creates basis to for second theoretical part, which is to understand obstacles that may occur and prevent implementation of VBP.

Theoretical framework based on literature review is then utilized in empirical part of the research.

Empirical part of this research is conducted with qualitative single case study method and data collection with 11 semi-structured interviews. The purpose of interviews is to bring together various perspectives, gather experiences and obtain understanding on how pricing management and VBP is seen in the Case Company. Based on data analysis goal is to recognize in more detail way how pricing management is understood in Case Company, what is the role of pricing function in this context, which internal stakeholders are most important in process of implementing VBP and especially to understand why implementing VBP is challenging from their perspectives. The structure of the thesis is demonstrated in Table 1.

Table 1. Structure of the research

Chapter Title Purpose

1 Introduction Introduction of the research

2 Strategic Pricing Theoretical chapter discussing pricing as strategic approach and pricing management

3

Obstacles in value-based pricing strategy

Theoretical chapter discussing barriers to VBP and overcoming obstacles to VBP

4 Methodology Methodology used in the research

5 Findings Findings on how pricing management and role of pricing function is understood, and the key barriers related to VBP 6 Conclusions Conclusions of the research

7 Managerial Implications Managerial implications to understand role of key stakeholders in implementing VBP and recommend actions

8 Summary Summary of the research

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2 STRATEGIC PRICING

In the marketing mix concept of the 4Ps consisting price, product, place and promotion it has been argued that pricing is the most important element as it is the only one that generates directly revenue (Lowengart & Mizrahi, 2000; Indounas & Roth, 2011). Whereas industrial companies have seen that they can influence more in other elements of marketing mix, pricing has been seen as completely dictated by the markets (Lancioni, 2005a). In order to compete in markets it is argued that approach towards pricing management should be seen more as strategical rather than as tactical (Dutta, Bergen, Levy, Ritson & Zbaracki, 2002).

2.1 Pricing as strategic approach

Kotler and Armstrong (2012, p.290) define price as “amount of money customers charged for a product or service; the sum of the values that customer exchange for the benefits of having or using the product or service.”

In order to successfully managing pricing, it needs to be understood that setting prices tactically is not enough (Dutta et al. 2002). As Nagle and Holden (2002, p.149) define it,

“the difference between price setting and pricing strategically is the difference between reacting to market conditions and proactively managing them.” Whereas price setting is seen as just one tactical element in a sales process, pricing strategy refers to more comprehensive co-ordination of maximizing profitability by taking account marketing, competitive and financial decision in account (Nagle & Holden, 2002, p.149).

In order to generate profitable sales, prices will need to be higher than the costs but at the same time meet the customer’s perception of value. If the price is above customer’s perception of value, no sales will result. If the price is below company’s costs, it will result as negative margin. Price ceiling represents the maximum amount of customer perceptions of value whereas price floor is based on the cost level of company. External and internal factors such as competitors’ strategies and prices, the overall marketing strategy and mix as

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well as the nature of the marked and demand are needed to be addressed as well. This will serve as starting point for companies in price setting consideration process. (Kotler &

Armstrong, 2012, p.291.) Framework of price ceiling and floor is illustrated in Figure 2.

Figure 2. Consideration in setting price (adopted from Kotler & Armstrong, 2012, p.291)

The motivation for seeing as pricing as strategic approach is inevitable. As Hinterhuber (2003) mentions the impact of price on profitability is significant. However, pricing is often seen more as source of frustration rather as an opportunity to increase profitability from industrial company perspective as it has been felt that customers are in control of the prices (Lancioni, 2005a).

In order to answer to demands of changing market enviroment companies often change their prices. Kotler and Armstrong (2012, p. 319) lists seven price adjustment strategies:

discount and allowance pricing, segmented pricing, psyschological pricing, promotional pricing, geographical pricing, dynamic pricing, and international pricing.

According Hinterhuber (2008) there is significant variance in different pricing strategies depending on industries, countries and customers. Nevertheless, different strategies can be divided into following main groups: cost-based pricing, competition-based pricing and customer value-based pricing (Hinterhuber, 2008).

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Key thing to understand when talking about differentiation between cost-based pricing and customer value-based pricing is to understand chain of events in both approaches illustrated in Figure 3. (Hinterhuber & Liozu, 2013, p.108)

Figure 3. Pricing chain of different pricing strategies (Hinterhuber & Liozu, 2013, p.108)

In cost-based pricing customer is considered as last objective of pricing process. This leads to situation where price is first set based on costs but not taking account customers’ view.

Company needs to hope that customer will value output higher than price what is charged from them. In value-based pricing chain has been inverted to reflect realties of the markets.

Customers do not care about sales companies’ internal costs or desired margin levels but they demand value that is higher than price charged from them. (Hinterhuber & Liozu, 2013, p.108)

When analyzing these differences it actually reveals further fact that it is not costs that should determine sales prices but it is actually the opposite; sales prices should be determining costs. A company has to evaluate whether the charged price will allow it invest in costs required to develop the product or service at desired profit level, before decision to produce product or service has been made. If costs levels prevents in making profitable business production should not be done in first place. Key thing is to understand that costs should be considered before production has taken place instead of setting price after production has been already done and costs already exist. (Hinterhuber & Liozu 2013, p.108)

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2.1.1 Cost-based pricing

Cost-based pricing has been in retrospectively the most common pricing strategy mainly due in many ways it is the simplest way to do pricing. In addition, cost-based pricing has been seen as most safest pricing strategy from profitability perspective where in a nutshell items sales price have been generated by adding desired profit amount on top of the cost of the item. (Schindler, 2012, p.21).

As Hinterhuber (2008) lists there exists wide terminology what are used when talking about cost-based pricing such as cost-plus pricing, mark-up pricing and target-return pricing. In addition, other terminology is introduced in various publications. Nevertheless essentially all of these concepts are based on adding percentage or monetary value on top of the cost. Thus in this research only term Cost-based pricing is later referred.

Reason why cost-based pricing has gained popularity is the simplicity of the strategy.

Especially it has been seen important to have simple method when there is large amount of items with potentially similar characteristics to be priced such as in wholesaling and retailing. Using cost-based pricing has been also justified by maintaining prices in similar level within markets and avoiding over- or underpricing items compared to competitors.

This idea has been based on impression that per-item costs are often similar to costs for ones competitors have. By adding commonly used amounts, that are thought to be used also by other companies on top of costs, prices have seen to be in competitive level thus reducing need to do proper research in competitors actual sales prices. (Schindler 2012, p.27)

Although cost-based pricing is widely used pricing strategy it has been seen also seen as weakest pricing strategy. As in theory it can look like a simple and safe method to profitable business in practice often it will actually limit level of company’s financial performance. (Nagle, Hogan and Zale, 2014, p.2.) Fundamental problem with cost-based pricing is presumption that by looking first at costs when setting sales prices profitability can be insured on those items that are sold. Although this would actually mean that ones that are sold do have also desired profit percentage, it might limit more important measure

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of total profits. If added amount expected to generate desired profit results prices that are considered too high from customers perspective result can be smaller sales amounts than expected. In this kind of example total profit can be extremely disappointing and not cover all costs as profits gained from sold items might be not enough monetarily compared to expected sales volumes and total profits. Vice versa by adding desired profit amount on top of cost can also result in price that is actually lower than customers would be willing to pay. In this scenario there would be potential to generate more total profit than would be expected thus limiting financial performance. (Indounas, 2006.)

Another issue with cost-based pricing is that in most industries unit costs tend to change with volume. This leads to problem where pricers need to first determine average unit cost and thus making assumption that price can be set without effecting on volume. The errors made in evaluating effects of price on volume and of volume on cost actually will lead situations where managing prices with profitability being key driver becomes impossible.

Attempts to cover these errors may even create bigger problems. If costs have been underestimated in beginning in order to cover costs prices are increased. This can further increase actual unit cost as higher price may decrease sales levels. According theory prices should be still further increased though. In contrast if average unit costs have been overvalued and still resulting higher sales than expected it would mean that prices according theory should be decreased, as average unit cost would be actually lower than when cost-based pricing was done. In another words cost-based pricing results to overpricing when markets are weaker and underpricing in strong markets. This is exactly opposite what usually is targeted in sage pricing strategy. (Nagle et al., 2014, p.3)

Clear problem with cost-based pricing is also that it does not take account customers willingness to pay into account. Customers view on price does not change even selling companies costs would be changing. In cost-based pricing also too often favorable actions in sourcing and supply departments are directly transferred to customer. Sourcing and supply savings generated by negotiating better discounts from vendors should not be automatically transferred to sales prices. Instead of lowering prices, these savings could be maintained inside company making business thus more profitable. (Hill, 2013, pp. 49-50)

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Although cost-based pricing is criticized, it does not mean that cost-based pricing would result failure at least in short term. Many companies exist who make profitable business with using cost-based pricing. Some companies have even developed more dynamic cost- based models to manage their pricing. Key question and issue for this kind of model would be still how much more profitable these companies could be and which margin level would be enough? (Liozu, 2016a, pp.17-18)

2.1.2 Competition-based pricing

In competition-based pricing price, setting is based on examination of competitors’ prices.

Goal might be as well to match yourself with similar prices competitors have but also can mean setting higher or lower prices desired contrast to competitors’ prices. (Schindler, 2012, p.29)

As Hinterhuber (2008) states that in competition-based pricing markets are taken account better than in cost-based pricing thus making it more sophisticated strategy. Actually completion-based pricing strategy is considered most common approach in various companies in different markets. Competition-based pricing has been seen as optimal approach in situations where company’s offering cannot be differentiated in any forms with competitors offering. Example of this kind of business can be selling of commodities.

(Hinterhuber, 2008)

Competition-based pricing shares similar kind of advantages as cost-based pricing does possess. It is intuitive approach as often it has seen that it is important to set prices in similar levels than competitors have in order to maintain interest of customers. In addition it is not the most complex approach setting prices as in principle it is just adding or subtracting desired amount from prices set by customers. (Schindler, 2012, p.29)

In competition-based pricing decision on desired price levels can be made in taking account different kind of competitors prices. Prices can reflect highest, lowest or average competitor prices in markets. Also price level can be pinpointed to focus in certain competitors only. Competitor to be compared can be the one that is considered to be most

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similar, most dominant, most prestigious or potentially the competitor which is growing the fastest and making a difference in markets. (Schindler, 2012, p.29)

When talking about the challenges in competition-based pricing the most evident issue is obtaining competitors prices. In many markets, prices are not visible to other parties than seller and buyer. Buyer might have even incentives to share wrong information to seller in hope of decreased prices. Even the shared prices for other parties might not been the actual prices used as often prices are end results of private negotiations. Therefore, in order to be able set prices based on completion it usually is not enough to just gather information and rely on it. It also needs further evaluation in terms of analyzing what would be competitors’ likely costs, strategies, profit margins and other elements of competitive intelligence. (Schindler, 2012, p.29)

Competition-based pricing also has disadvantage of potentially leaving money on the table and limiting financial performance; similar to cost-based pricing. True value of items is not taken account and thus customer’s willingness to pay is not challenged. Especially in markets of items where competition-based pricing has been normal for longer period company might be facing a situation where market prices are just result of constant imitating of competitor’s prices rather than truly rationale prices related to the value of item. (Schindler, 2012, p.29)

2.1.3 Customer value-based pricing

Hinterhuber (2008) defines value-based pricing as following: “Customer value-based pricing approaches use the value a product or service delivers to predefined segment of customers as the main factor for setting prices.” The biggest advantage of VBP that in basis of price setting is needs of the paying customers (Hinterhuber & Liozu, 2012). Liozu (2016a, p.23) states that VBP’s overall goal is not in higher prices or even better pricing but it targets that price correlate with the true value of the products. When comparing different pricing strategy groups customer value-based pricing strategy is generally seen as superior to other pricing strategies in taking account customer value (Cannon & Morgan, 1990; Codini, Saccani & Sicco, 2012). .Ingenbleek (2007) states that companies have put

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more focus in understanding customer’s value perception as industrial companies have been facing price pressure. Forbis and Mehta (1981) add that offering better customer value can lead to increase of competitive position with even higher prices.

Key challenge in VBP is that obtaining and analyzing data related customer preferences, willingness to pay, price elasticity and size of different market segments can be difficult.

As VBP is most often used with highly competitive industries where products generally have high level of value and products can be even unique, it generates risk that prices are set in relatively high level. This may seem tempting at the beginning but it can also create scenario where competitors may enter the markets offering similar kind of products with lower prices. Before VBP can be utilized there is need to communicate the value aspects, as customers need to recognize the value also in order to be ready to pay asked price.

(Hinterhuber & Liozu, 2012)

Customer value-based pricing is still not widely used approach. Cost-based pricing and competition-based pricing are mainly adopted pricing strategies within majority of industries. (Hinterhuber, 2008). Key shortcoming recognized by Liozu et al. (2011) is that executives do not understand the concept of VBP. Another reason for the low level of adaptation of VBP is that many companies see their products more as commodities rather than value-potential products thus not seeing VBP providing any competitive advantage (Hinterhuber & Liozu, 2012). In addition, the requirement of deep cross-functional co- operation in VBP can create obstacles in implementation of the strategy (Nagle et al. 2014, p. 204).

In context of VBP, it is important to understand what is meant with value. According to Johansson (2013, p.186), customer perceived value and differentiation value are the main value definitions in VBP. Töytäri, Turunen and Rajala (2014, p.122) divide perceived value into functional value, strategical value, symbolical value and social value in pricing context. Liozu, Hinterhuber, Boland and Perelli (2011) define value in VBP as “to the maximum amount a customer will pay to obtain a given product or service, in other words, the price at which the customer is equally indifferent to purchasing and to foregoing the purchase.”

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Smith and Nagle (2005) present total economic value as the starting point for value communication for customer. Total economic value is calculated as the reference value plus the differentiation value. Reference value equals to customer’s best alternative price.

Differentiation value accounts as the incremental use value that is delivered compared to substitutes. Differentiation value can be either positive or negative based on the monetary and psychological value. Monetary value equals as the savings or income of purchasing the product and psychological value as the innate satisfaction product creates. (Nagle et. al, 2012, p. 19.) Total economic value not necessarily is the price that customer is willing to pay as factors such as uncertainty about the promised benefits, switching costs and perceptions of fairness will affect. However, total economic value will work as anchor point for measuring true value of the product and it will give comparison point for evaluating actualized sales prices. (Smith & Nagle, 2005.) Total economic value is illustrated in Figure 4.

Figure 4. Economic value (Nagle et al. 2014, p.20)

Nagle et al. (2014, p.7) lists that there are five distinct yet different sets of choices in the process of implementation of VBP: value creation, price structure, price and value communication, pricing policy and price level. In Figure 5 these choices are illustrated.

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Figure 5. The Strategic Pricing Pyramid (Nagle et al., 2014, p.7)

In value creation phase, aspects estimating total economic value needs to be taken account.

Estimating total economic value requires understanding of what are competitive reference prices and estimating monetary value as well psychological value for defining differentiation value. Also customers need to be segmented based on their characteristics in order to further continue with implementation of VBP. (Nagle et al., 2014, pp.7-9)

Price structure phase focuses in defining different metrics and fences to be utilized. Pricing metric is unit of which price is applied. Instead of just focusing on product of single price, with metrics such as performance-based, where price is based on the directly on the economic value and the incremental cost to serve rather than charges of installation.

Another aspect in price structure phase is defining price fences. Price fence is the differentiating aspect where different customers are charged with different prices on the same products and the same metrics. Fences can be related to buyer identification, purchase location, time of purchase or purchase quantity for instance. (Nagle et al., 2014, p.55)

Price and value communication is essential part of VBP process. Even if there would have been success in earlier stages by understanding the value of the products and translated it into price accordingly, it is not enough if customer can’t recognize the value. Important

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aspect in value communication is to understand in which stage of buying process the customer is. Buying process can be divided to different stages based on whether customer is already comparing products before expected transaction to early stage where customer is just have become aware of possible need of a product. (Nagle et al., 2014, pp.75)

As the last stage of implementation is price setting. Even the significance of earlier stages cannot be underestimated, as price-setting task is perhaps the most challenging stage due great impact for business performance. Two most important aspects that need to be taken account before setting prices are whether prices are aligned with overall business strategy and how customer is expected to answer new prices. (Nagle et al., 2014, p. 130)

2.2 Pricing management

2.2.1 Managing strategic pricing

Lancioni (2005b) states that pricing is often seen so dependent on other functions that establishing single function dedicated to pricing as well as having own pricing plan is impossible. As pricing decisions are also reflecting other functions such as sales, marketing, senior management, finance, manufacturing and customer service, questions have been raised how one function would be able represent interests of everyone simultaneously (Lancioni 2005b). Common reason for pricing strategies to fail and to be inconsistently implemented is linked to conflicted motivations of decision makers without possessing enough information or expertise related to pricing management (Nagle et al., 2014, p. 205).

Dutta et al. (2002) addresses that in order to manage pricing efficiently and turning pricing into “strategic weapon” company needs to invest in order to generate pricing capabilities.

Investments to human capital, systems capital and social capital create basis for company to establish routines in price setting and shift away from ad hoc pricing. (Dutta et al., 2002). In order to utilize pricing capabilities there needs be organizational infrastructure that supports successful pricing management (Baker, Marn & Zawada, 2010). Burkert,

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Ivens, Henneberg and Schradi (2017) mention that even when sophisticated pricing methods, tools and systems are introduced, successful implementation is not possible without organizational backbone of pricing. Carricano, Trinquecoste and Mondejar (2010) argue that establishing separate pricing function is key step in pricing management. Baker et al (2010) add that pricing function should be separated from units negotiating with customers and serve as healthy opponent for sales units by challenging them to use set prices. Successful pricing will not happen without systematic design of pricing organization where initiative for changing organizational structure comes from senior executives (Burkert et al., 2017).

2.2.2 Organizational structure of pricing function

The role of pricing function can be classified with the ownership level of pricing decisions and pricing procedures. Nagle et al. (2014, p. 208) categorize four types of roles for pricing function: expert resource, functional coordinator, commercial partner and figurehead.

Expert resource role is commonly adopted approach in industries such as chemicals and manufacturing where the capability on evaluating customer value is crucial. Expert resource can be effective when business units are operate with similar kind of data but market characteristics are different. As the ownership level of pricing procedures and decisions is low, role of pricing function is rather operate as internal consultant supporting other functions. Functional coordinator role has more power in pricing procedures and serves more as tactical advisor in terms how decisions are done rather what is the end result. Ownership of pricing decisions is still obtained by senior marketing and sales executives. (Nagle et al., 2014, pp. 207-208.)

As pricing function has the role of commercial partner it has both the ownership of pricing procedures and pricing decisions. However, rarely even in commercial partner role all power given to the function but usually it works in partnership with other commercial executives. Figurehead role is seen as most difficult one as pricing function has the right to make the key pricing decisions but has lacks in power to control pricing decisions in market areas. Function has low level of credibility and it often leads to other functions to do pricing decisions without formal authority. (Nagle et al., 2014, pp. 207-208.)

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Another aspect in organizing pricing function is to define the degree of centralization.

Liozu and Ecker (2013, p. 31) lists four types of pricing organizations: decentralized, centre-supported, centre-led and centralized. In decentralized pricing organization all pricing power is given to sales force. Focus is in generating revenue rather than profit and discounts are commonly used. In decentralized pricing individuals possess all the information related to pricing increasing risk of losing silent knowledge if individual leaves the company. Centre-supported pricing is mainly evaluated by the success of process development. Centre-supported pricing role is often established when there is recognized a need for pricing management but giving decision making power is not been wanted to share. This will result as a function that is formally responsible of pricing yet having low level of power in terms of pricing management. Benefit of centre-supported role is that it allows flexibility for sales force to operate and simultaneously pricing processes are developed. It may give an illusion for company that pricing is actually managed but that is not true as pricing function have limited amount impact to pricing decisions. (Liozu & Ecker, 2013, p. 31)

Centre-led pricing is the most ambitious approach as there focus is establishing pricing expertise at the strategical level and share knowledge for other functions to be utilized.

Collaboration exist with sales functions as well as with others. Although centre-led pricing function would not possess pricing power, it is evaluated by profitability performance of other functions hence motivating truly to share their expertise around organization. In centralized pricing organization has the maximum level of control in pricing. In bigger companies, it may provide consistent pricing for all customers. However, the strong level of governance may create disempowerment in sales force. Due the strict nature of the approach, all pricing decisions are needed to be approved by pricing functions. This may lead to situations where sales force need to buy time with customers as it takes more time before pricing approval process in completed. (Liozu & Ecker, 2013, p. 32)

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2.2.3 Pricing council

Key step in ensuring successful price management and development is creation of pricing council. It guarantees that on regular basis a group of experts spend time dedicated to the management of pricing Pricing council creates a forum for discussion of major pricing topics such as key KPI’s, competitive data and new product pricing. Often pricing council consists key experts from various departments. (Crouch & Hunsicker, 2013, p. 180)

Among pricing professionals pricing councils have become acknowledged and useful organizational tool that provides a space for thorough review of all pricing activities. When establishing pricing council, there are certain key questions that needs to be considered:

- How pricing council is framed?

- Who is part of pricing council?

- How frequently pricing council meets and for how long?

- Where pricing council meets?

- What the agenda look like?

- How council actions are communicated? (Liozu, 2016b, p. 89)

Presence of top management is one of key aspects in successful pricing council. It has been considered to be one of the best ways to elevate the conversation, to get people to participate and to get quick decisions made. Otherwise pricing council should consist people from several departments such as sales, marketing, pricing, finance, innovation, management, R&D, operations. The science and art of pricing should be distributed to as many peoples as possible. At the same time, it is also important that there is balance of topics related to cost, competition and customer value. As pricing council consists a multifunctional team, each participant is responding to different information in a unique way. (Liozu, 2016b, pp. 89-90)

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Tensions and conflicts cannot be avoided when discussing pricing as a subject. Pricing council should offer a forum where people should be able to vent, share and give constructive feedback on topics related to pricing. Addressing tough issues, potential tensions and organizational breakdowns in a safe and nonjudgmental environment can help greater alignment in pricing tactics. Continuous improvement should be cherished in pricing council instead of finger pointing for difficult pricing situations or bad pricing decisions. It is important to create environment where people have mindset to openly discuss on problems and seeking resolutions as a team. Value and pricing management can be complex and therefore open and mindful discussion together can at least ease in solving the issues. Sharing scientific data supporting to price levels for instance also helps to eliminate subjectivity and judgment thus increasing level of rationality in pricing management. Most importantly pricing council should be place of creative exploration and experimentation. In dynamic and completive global business world pricing strategies have to be also developing constantly and cannot be static. Therefore in council meetings there should be always also have time to discuss where to focus and constantly challenge current pricing strategies in terms of are the effects similar as they were originally expected.

(Liozu 2016b, pp. 90-91)

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3 OBSTACLES IN VALUE-BASED PRICING STRATEGY

Although VBP is generally is acknowledged as superior to all other pricing strategies (e.g.

Ingenbleek, 2007, Monroe, 2002) it still plays a relatively minor role when comparing what pricing strategies are used in companies (Hinterhuber, 2008). Therefore it is imminent that there exists obstacles and barriers why VBR has not been implemented in different companies as often as it should been based on recommendations of researchers when comparing it to alternative and less sophisticated pricing strategies and approaches.

3.1 Organizational obstacles in value-based pricing

Töytäri, Rajala and Brashear Alejandro (2015) identify three organizational and institutional barriers to VBP in B2B relationships: understanding and influencing the customer’s desired value, quantifying and communicating value in buyer-seller relationships, challenges in capturing a share of the value created in industrial exchange.

Hinterhuber (2008) recognize five main obstacles that prevent implementing VBP strategy from organization perspective. These are value assessment, value communication, market segmentation, sales force management and senior management support.

3.1.1 Value-assessment

The principle problem in value assessment is lack of methods, tools and information to assess customer value and it. It is also considered to be often the main obstacle towards implementing VBP. Due these obstacles, companies are often forced to choose cost-based or completion-based pricing strategy as evaluating customer perceived value reliably is not possible. Occasionally scenario can be that even marketing and sales departments are not sure from which factors customer perceived value is based on. Therefore companies often end up discussing on technical abilities and attributes instead of focusing the benefits and the value that customer would gain based on these technical aspects. (Hinterhuber, 2008;

Hinterhuber & Bertini, 2011)

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Quantifying customer value is often considered as challenging task especially for industrial companies (Storbacka, 2011). According to Töytäri et al. (2015) however industrial companies do not utilize comprehensively different value aspects when trying to quantify customer value. Often only operational dimension of value is systematically quantified and leveraged as basis of VBP (Töytäri et al., 2015).

Barriers in quantifying value often are reflecting from lack of trust between parties. In order to better quantify customer value seller would need to have access to customer’s base line data. Other aspects such as confidentiality and rivalry also play role when customer is reluctant to share their numerical data for seller. One key reason for hesitance towards sharing information is that seller might discover an undesired value aspect from buyer perspective and utilize it by increasing prices towards customer. (Töytäri et al., 2015).

Even if value would have been successfully agreed, created and quantified dividing shares of value between seller and buyer can be difficult. Institutionalized barriers especially of cost-based pricing, appreciating of bargaining power and managing uncertainty in value creation needs to be addressed. (Töytäri et al., 2015).

3.1.2 Value communication

With value communication often the basic problem is the question of what value aspect should be communicated for customer. Although product might have features and characteristics that would surpass competitors’ products it is not guaranteed that it customer would perceive the value as similar. Communicating value efficiently to customers is challenging especially in inundated markets. Related to challenges in value assessment phase, communication tends to also concentrate only technical attributes instead of focus being in the performance what it actually means to a customer using the product. Off-handed communication may also lead to situation where customer concentrates more in the actual price rather than value aspects thus making it difficult to utilize VBP. (Hinterhuber, 2008; Hinterhuber & Bertini, 2011)

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Buyer’s desired value perceptions are often difficult to be changed. Buying and procurement operations are guided by combination of business beliefs that have been generated in the past and have strong presence. Sometimes these beliefs can be somewhat outdated but changing the current status quo cannot be executed without strong relationship between seller and buyer. Especially in mature industrial business markets, sales-based influencing is often reactive. Buyer has already determined the value factors they desire often with a strong focus in initial cost savings. This leads little room to influence desired value other than lowering price. (Töytäri et al., 2015)

If buyer is seeing the initial purchase price as the most important factor it is unlikely that more holistic measures of business performance would be appreciated. Value-based concepts such as total-cost-of-ownership are not necessarily understood making it more difficult for seller to convince true value. (Töytäri et al., 2015)

In addition, individual incentives sometimes create goal conflicts compared to whole organization performance. For instance buyers may been rewarded for price savings but at the same time it can actually hurt overall business performance through increasing total cost of ownership. It is also common that individual incentives may drive to generate results in short-term thus making it difficult convince them if value proposal focuses in long-haul advantages. Some buyers might even appreciate more long-term relationships but it needs to be understood that convincing buyer to change partner can be extremely difficult due high switching costs. (Töytäri et al., 2015)

3.1.3 Sales force management and senior management support

Common problem with sales force management is the lack of incentives related to focusing in value from price perspective. Sales teams put focus is qualifying bonus targets related to sales volumes by handing out discounts without understanding the long-term consequences related to designed value-based price. (Hinterhuber, 2008)

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In addition, lack of senior management plays a role. Often senior managers share a view that high market share will automatically also result high profitability. Sales managers are thus encouraged to reach market share targets and given less recognition in meeting the value-based prices. (Hinterhuber & Bertini, 2011)

3.1.4 Market segmentation

Key problem related to market segmentation in industrial markets is that is often too intuitive and relying only on easily observable yet ineffective criteria (Hinterhuber &

Bertini, 2011). Hinterhuber (2008) adds that marketing theory has not provided usable methods and tools for marketing practicers to execute market segmentation effectively.

Liozu (2016a) lists five challenges with B2B segmentation:

- Reliance on traditional segmentation criteria

- Lack of marketing sophistication, customer knowledge, and relevant qualitative and quantitative data

- Traditional and legacy organizational structures that are difficult to change

- Focus on 100% accuracy, leading to analysis paralysis in technically sophisticated B2B companies

- Change resistance when segmentation is not done collaboratively

- Lack of commitment to execution due to change complexity (Liozu, 2016a, p. 75)

3.2 Barriers to value-based pricing from individual perspective

In order to gain better understanding of barriers to VBP Töytäri, Keränen and Rajala (2017) argue that individually induced barriers have effect in addition to organizational and institutional barriers. As often it is assumed that pricing decisions and strategies are operated by organizations, it is actually individual actors who drive implementing VBP.

Barriers to VBP are divided to into types of individually, organizationally and externally induced barriers as illustrated in Table 2. (Töytäri et al., 2017)

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Table 2. Individually, organizationally, and externally induced barriers to value-based pricing (Töytäri et al., 2017, p.241)

Individually induced barriers Organizationally induced barriers Externally induced barriers

Beliefs and attitudes Product-oriented sales culture Prevailing buiyng culture

Experience and skills Governance and tools Incompatible value conceptious

High cost and complexity of value

quantification Inefficient customer selection Supplier's brand identity Incompatible time horizons Value sharing power within the network

Individually induced barriers are reflections of beliefs and values an individual possesses.

Both organizationally induced barriers as well as externally induced barriers affect to individually induced barriers. Externally induced barriers are reflections of general industry norms and from established customer relationships. Organizationally induced barriers are more connected to existing organizational culture. (Töytäri et al., 2017)

Töytäri et al. (2017) recognized in their study that individually induced barriers to VBP are related to beliefs and attitudes, lack of experience and skills, as well as high cost and complexity of value quantification. Individuals own eeply prevailed attitudes towards whether themselves can understand VBP compared or even hesitance towards implementing VBP occurred. In addition, it was seen that that lack of skills towards pricing based on potential value instead of perceived characteristics or technological aspects can create barriers. Value quantifying was also felt as time consuming but at the same time not generating enough beneficial results thus resulting hesitance. (Töytäri et al., 2017)

Organizational induced barriers were related to product-orientated sales culture, governance and tools, and lack of customer segmentation. For instance if company has strong heritage in concentrating product features with maximizing short-term profits implementing VBP can be difficult. Also internal processes, IT systems as well as rewarding and incentives are often designed with different requirements and to serve different purposes thus not supporting VBP. (Töytäri et al., 2017)

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Externally induced barriers are based on the reflections that occur in customer interface.

Töytäri el al. (2017) findings were related to prevailing buying culture, incompatible value conceptions, the supplier’s brand identity, incompatible time horizons and value-sharing power within the network. Industrial buyers are often given task to obtain products with the lowest price based on predefined requirements making it difficult to influence in customers value perceptions. Due nature of customer selection being reactive it may result as generic pricing approach for every customer instead of recognizing proactively customers that might be more interested in value-based prices. It can be also difficult to convince customers regarding higher prices due value as often short-term gains are seen more important. Additionally it can be difficult to justify VBP if it cannot be explained and utilized in entire industrial value-chain. (Töytäri el al. (2017)

Figure 6. Individually perceived barriers to VBP and the legitimation of VBP (Töytäri et al., 2017, p.244)

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Organizational and external barriers can prevent individual pricing activities. In order to overcome these barriers legitimation of VBP needs to happen in different levels though sensegiving. As individuals act together with each other’s their perceptions and views can have effect in more broader scope thus effecting barriers on individual level as well also in organizational and external level. (Töytäri et al., 2017) In Figure 6 both positions of induced barriers as well as sensegiving processes in different levels is illustrated.

3.3 Remedies for value-based pricing implementation

3.3.1 Overcoming obstacles

Hinterhuber and Bertini (2011) lists set of recommendations on how obstacles to VBP could be overcome. Best practices are listed in Table 3.

Table 3. Overcoming the obstacles to value-based pricing (Hinterhuber & Bertini, 2011)

Main Obstacles Manifestation Best practice

Value assessment

Value

communication

Lack of methods, tools or information to quantify customer value

Customer value is quantified with robust empricial research such as conjoint analysis, expert interviews or value-in-use

assessments Communication encourages customers to

fixating on price

Communication centers around product features and technical product characteristics

Communication discourages customers from fixating on price

Communication translates key product features into customer benefits or business impact

Senior management support

Senior management is mainly interested in top- line growth or market share and does not encourage a focus on value

Senior management provides vision, context and incentives to implement value based pricing

Market segmentation

Market segmentation is intuitive or based on easily observable but ineffective criteria

Needs-based market segmentation drives marketing strategy

Sales force management

Lack of incentive schemes and guidelines to encourage sales force to focus on value

Sales force has capabilities, guidelines and motivation to focus on value. Training and monitoring systems are in place.

Discounting is not encouraged

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When there is better understanding of customer value it enables also to evaluate customer willingness to pay with higher confidence. In order to successfully implement VBP a series of empirical tools to reliably measure customer value needs to be employed. Hinterhuber and Bertini (2011) lists tools such as conjoint analysis, expert interviews and customer value-in-use assessment to be used. (Hinterhuber & Bertini, 2011)

Keränen and Jalkala (2014) identify three strategies for customer value assessment:

emergent value sales strategy, life-cycle value management strategy and dedicated value specialist strategy. These strategies are used either separately or in combination of two or all of three strategies together. Best results are gained when all three strategies are used together. In emergent value sales strategy sales unit has the responsibility to assess customer value, usually only from sales perspective and ad hoc. In emergent value sales strategy value assessment is dependable on the skills and motivation of individual salesperson involved in the delivery. Life-cycle value management strategy aims to conduct customer value assessment more thoroughly in terms of involvement of different departments. Strategy relies strongly on forecasting and that responsibility of value assessment switches smoothly from one internal department to another among the process.

In dedicated value specialist strategy responsibility of identifying customer value, measuring baseline and documented realized value in all phases of delivery process is given to separate value specialist team working cross-functionally within the organization.

(Keränen & Jalkala, 2014)

Senior management needs to recognize profitability as more important driver than market share. It requires also that senior management define clear strategy and support salesforce for using value-based prices as starting point with customer negotiations. In addition, senior management needs to monitor development and reward as well as reinforce desired practices constantly. (Hinterhuber & Bertini, 2011)

In value communication, focus should be in turning discussion away from the price and concentrate on value. Hinterhuber (2008) lists three level of sophistication need to be recognized: communicating product features, communicating customer benefits and communicating benefits in accordance with customer needs. Communicating product

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features in the most basic level of communication of value. However, the disadvantage is that customers may not be interested in technical aspects. In communicating customer benefits focus is in discussing about the benefits using product would obtain. Challenge with this approach is that companies may have problems in recognizing the benefits customer pursues. The most sophisticated approach is communicating benefits in accordance with customer needs where company recognizes the larger good what customers would obtain rather than just listing benefits. (Hinterhuber, 2008.) Töytäri et al.

(2017) support development of documenting and communicating value as a sensegiving strategy.

Sales force should have capabilities, guidelines and motivations to focus in customer value.

Encouragement of allowing discounts should be avoided. However, certain freedoms for discounting can be considered to be given in situations where sales personnel possess more information regarding customers’ willingness to pay, products are complex or they have excellent negotiating skills. Rewarding and incentives systems in order to motivate sales force to concentrate in value and profitability instead of just sales volumes should be developed. Training of sales force is also considered as important action. As changing mindset of personnel from product-orientated sales to value-based sales is big transformation it cannot happen without proper training programs. (Hinterhuber, 2008.) Creation of value-focus training programs is also supported in Töytäri et al. (2017) findings.

3.3.2 Justifying VBP organizationally

In order to implement VBP strategy in organization and developing it through internal and external obstacles confidence has been seen extremely important factor. This means that pricing strategy must be in line company’s business model and long-term strategy. It is also important to understand that confidence in pricing is not something that can be created over night or something that organization could inherit. In optimal situation every person having some link to price setting have a mentality where there is strong belief in own doing, quality of offering, available tools and healthy self-confidence on level of competence compared to competitors. (Liozu, 2015, p. 136)

Challenges in implementing value-based pricing strategy